Getting Back to Basics With Gold

Gold Still In A Bull Market. Why Fundamentals Outweigh Short-Term Market Gains.

November 17, 2016

By: Claudio Grass,

2016 is gold’s big bull run. The precious metal rose close to 20% this year, pushed by a summer rally that peaked on July 10th. But then, gold experienced a bumpy ride during the remainder of the summer, as investors were concerned about the Federal Reserve’s decision on the rate hike. This volatility was underlined by the immense uncertainty that prevailed in the gold market.


“Trusting” the establishment a bit too much?

Investors are not entirely to blame, not when the officials were releasing misleading information. For example: Fed chair Janet Yellen stated at the Jackson Hole meeting of central bankers that the case for rate rises has “strengthened”, yet she gave markets little guidance on timing, saying the hikes would be “gradual” and happen “over time”. In effect, this discouraged investors from buying into gold, because they still trust the establishment and its credibility. A rate hike offers investors an alternative to owning gold, because gold doesn’t pay any interest. Moreover, higher interest rates tend to damp down inflation – this is also bad for gold.

But surprise, surprise! The Fed decided the time was not right to increase the rates after all. So, will this revive demand for the bullion? Initial market reactions seem to concur: after the Fed’s decision NOT to raise rates, combined with a weaker dollar, as well as economic stimulus in Europe and Japan, demand for gold has picked up once again. Gold’s bull run is still marching on and it has the steam to continue doing so for a while.

However, these are all short-term market considerations where bullion is seen as part of “buy-low and sell-high” strategies. This is indeed valid and effective, but gold is far more than that. We encourage investors to see the bigger picture, to look to gold for the long-term, instead of making short-term gains in reaction to the Fed’s interest rate decisions.

In case you haven’t heard: our system is failing!

We and many others have repeatedly warned our readers of the failure of our system, caused by the damage inflicted by central banks’ expansionary monetary policies. As we said before, our system will inevitably “shut down” as it will no longer be able to absorb all the extra cash that is being constantly pumped into the market.

Central banks are now in a lose-lose situation: prolonging this low/negative interest rate climate will only expand our “illusionary” credit bubbles and have a disastrous impact on our economies. If they decide to raise the rates, they will doubtlessly cause a severe recession. While they all are trying their best to avoid this, it is the inevitable outcome. And as the Austrian School of Economics warned, the longer we wait, the worse we will have to endure. Our economies today are in a down cycle, “dying a slow death”. The Fed’s decision not to hike only confirms this outlook!

Aside from these ongoing challenges, there are additional political risks and critical events in the coming months, the US presidential election being the most important. Now that the candidates have presented their views in all three debates, poll numbers show it’s a rather close race. In fact, right after the first debate Citigroup revised its position on Trump’s chances to win to 40% from a previous 35% likelihood. And what would that mean for gold? Well, according to Citigroup, “a Trump win would bring about higher volatility in gold and forex”, but they set a bullish scenario, where gold is predicted to rise to USD1’425 in 4Q 2016 (which includes the possibility of a Trump win). But even in the “base case” where Hillary wins, it could mean support for a more hawkish Fed, or at a minimum, a continuation of the status quo. Either scenario presents a positive case for gold, in both the medium and long term.

Apart from the U.S. election, there are other potential risks lurking ahead this year, even though they might not be making international headlines in the mainstream media. For one, Russia is set to transition its currency away from the dollar. This means that Russia has decided to disengage from the USD-based monetary system by adopting a national sovereign currency, which is aimed at supporting the ailing Russian economy and boost the demand for the Ruble. Russia has taken this step encouraged by China, which on October 1st joined the International Monetary Fund’s special drawing rights (SDR) basket. By joining this basket of reserve currencies, the Yuan is on par with the U.S. Dollar, the Euro, the Yen and British pound. This represents a milestone for China: not only is it recognized as a global economic power, but now that Yuan-denominated bonds will be issued, central banks will start adding Yuan assets to their reserves. With alternatives now available on the international market, dollar bonds could become less popular and as a result, the dollars will themselves not flow outwards, thus creating price inflation in the U.S. Between both developments, which will eventually put added pressure on the Dollar, the Fed will not have the luxury to print at will as it used to. Also, a weak dollar, would translate into higher demand for precious metals, which will in turn push gold market’s bull run even further. Although recent data suggests a climb in the dollar, and accordingly a mild decrease in gold prices – we need to look beyond that and consider the long-term trend.


Gold supply to reach peak levels by 2019

As we are talking about gold and the demand for it, we also need to look at the other side of the equation: the supply. Recently, the industry has been suffering from a supply crunch, which could very well lead us to peak gold production very soon. “Peak gold production may be reached within the next three years as miners fail to replace their reserves, according to Randgold Resources CEO, Mark Bristow. As shown in the chart below, this supply crunch is caused by a combination of lack of new discoveries and tighter budgets. Also, miners are digging out higher-grade material for a short-term gain, which can subsequently shorten the lifespan of a mine, according to Bristow. The world’s largest producer, Barrick Gold Corp., produced 7.5% less in 2Q 2016, compared to the same quarter last year. Similarly, AngloGold Ashanti Ltd., the third-largest gold miner, produced 12% less in 1H2016.


The bigger picture: Gold as a backup plan

I believe this picture couldn’t be clearer: We are in a vicious cycle in this monetary policy that is not fulfilling its objective. After looking at market factors, geopolitics and gold supply, one wonders why authorities are not putting an end to this downward spiral? The answer is: to maintain control! How else would the central banks be able to justify their “need” to keep rates down and print more money? The Fed attributes its decision not to hike to low inflation. The question is, are these numbers true? To verify, we refer to the next chart, where Incrementum used the inflation rate based on the calculation of ‘Shadow Stats’, which employs the methodology of the 1980s.


This chart shows that while the “official” price inflation according to the CPI averaged 2.7% per year, Shadow Stats’ methodology calculated an average rate of 7.6%! What does this tell you about strategic incentive to maintain the status quo?

It wouldn’t be surprising if the Fed promises to hike rates, only to move them back down. At the moment, however, it is so deep into the crisis, it opts to play it safe by keeping the rates just as they are, for fear of ending up in the same controversial situation as the ECB. The markets and the public will not sustain more negative rates.

We have to “get real”, as they say, and face the reality of our predicament: the monetary policy in place is designed to prolong our decline with weak currencies, low productivity and accumulation of debt. Worldwide, USD13 trillion worth of bonds with negative yields according to Merrill Lynch. And overall, about 3/4 of the world’s sovereign bond market trades at 1% or lower! In the midst of this chaotic environment, we are now also seeing the first major cracks in the banking sector: Headlines of Deutsche Bank’s dreaded collapse, under the weight of the USD14 billion fine imposed by the U.S. Department of Justice, to settle the claims that Deutsche Bank missold U.S. mortgage-backed securities before the financial crisis. Could this mean that Germany’s largest lender will have to be bailed out? “Banks in Europe are still choked with some €900 billion euros in bad debt left over from the last financial crisis”, according to Peter Dattels, the IMF’s markets and capital markets deputy director. This has the potential to deeply impact the already weakened European economy and could potentially lead to another stock market or Euro currency crisis, yet again. With so many question marks, it is, now more than ever, of paramount importance to hold gold.

While some market participants will keep looking for clues in Yellen’s statements, your investment decisions should not be based on questions like “to hike or not to hike” or “will there be a gold market correction” – that is simply superficial and shallow and ignores fundamentals. When stored in physical form outside the banking system, gold is the only form of insurance in our unsecure market environment.

Our case for gold is to consider the long haul. Whether or not there could be a gold market correction is not the issue. We trust the fundamentals: it is clear that we are still in the middle of the long-term rally for the bullion. Gold has not seen the end of it; there is still a long, long way to go.

This article appeared in the latest Global Gold Outlook Report and on November 1st, 2016 at Learn more about Global Gold’s financial freedom program.

About the author: Claudio Grass is a passionate advocate of free-market thinking and libertarian philosophy. Following the teachings of the Austrian School of Economics he is convinced that sound money and human freedom are inextricably linked to each other. Driven by his in-depth knowledge of monetary history, he became an Ambassador for the Mises Insitute in Auburn, Alabama. He is one of the founders of  

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